Price Variances and Efficiency Variances for Direct-Cost Inputs

Learning Objective 5 Compute price variances and efficiency variances for direct-cost categories

each price variance is the difference between an actual input price and a budgeted input price
each efficiency variance is the difference between an actual input quantity and a budgeted input quantity for actual output

Consider Webb’s two direct-cost categories. The actual cost for each of these categories for the 10,000 jackets manufactured and sold in April 2020 is as follows:

<p>A table shows actual cost for direct materials purchased and used by Webb</p>

The table depicts actual cost for direct materials purchased and used by Webb. The details of the table are as follows:

1. Square yards of cloth purchased and used: 22,200

2. Actual price incurred per square yard: 28 dollars

3. Direct material costs, 22,200 times 28 dollars: 621,600 dollars

<p>A table shows actual cost for direct manufacturing labor used by Webb</p>

The table depicts actual cost for direct manufacturing labor used by Webb. The details of the table are as follows:

1. Direct manufacturing labor-hours used: 9,000

2. Actual price incurred per direct manufacturing labor-hour: 22 dollars

3. Direct manufacturing labor costs, 9,000 times 22 dollars: 198,000 dollars

Let’s use the Webb Company data to illustrate the price variance and the efficiency variance for direct-cost inputs.

A price variance is the difference between actual price and budgeted price, multiplied by the actual input quantity such as direct materials purchased. A price variance is sometimes called a rate variance, especially when it’s used to describe the price variance for direct manufacturing labor. An efficiency variance is the difference between the actual input quantity used (such as square yards of cloth) and the budgeted input quantity allowed for actual output, multiplied by budgeted price. An efficiency variance is sometimes called a usage variance. Let’s explore price and efficiency variances in greater detail.

Price Variances

The formula for computing the price variance is as follows:

$\begin{matrix} Price \\ variance \end{matrix} = ( \begin{matrix} Actual price \\ of input \end{matrix} - \begin{matrix} Budgeted price \\ of input \end{matrix}) \times \begin{matrix} Actual quantity \\ of input \end{matrix}$

The price variances for Webb’s two direct-cost categories are as follows:

<p>A table shows price variances for Webb’s two direct-cost categories</p>

The table depicts actual price of input minus budgeted price of input times actual quantity of input to reach price variance; this is done for direct materials and direct manufacturing labor. The details of the table are as follows:

1. Direct materials

Actual price of input: 28 dollars per square yard

Minus

Budgeted price of input: 30 dollars per square yard

Times

Actual quantity of input: 22,200 square yards

Equals

Price variance: 44,400 dollars F

2. Direct manufacturing labor

Actual price of input: 22 dollars per hour

Minus

Budgeted price of input: 20 dollars per hour

Times

Actual quantity of input: 9,000 hours

Equals

Price variance: 18,000 dollars U

The direct materials price variance is favorable because the actual price of cloth is less than the budgeted price, resulting in an increase in operating income. The direct manufacturing labor price variance is unfavorable because the actual wage rate paid to labor is more than the budgeted rate, resulting in a decrease in operating income.

Managers should always consider a broad range of possible causes for a price variance. For example, Webb’s favorable direct materials price variance could be due to one or more of the following:

Webb’s purchasing manager skillfully negotiated lower direct materials prices.
The purchasing manager switched to a lower-priced supplier.
The purchasing manager obtained quantity discounts by ordering larger quantities.
Direct materials prices decreased unexpectedly due to an oversupply of materials.
The budgeted purchase prices of direct materials were set too high because managers did not carefully analyze market conditions.
The purchasing manager negotiated favorable prices because he was willing to accept unfavorable terms on factors other than prices (such as agreeing to lower-quality material).

How Webb’s managers respond to the direct materials price variance depends on what they believe caused it. For example, if the purchasing manager received quantity discounts by ordering a larger amount of materials than budgeted, Webb’s management accountants would investigate whether the quantity discounts exceeded the higher storage and inventory holding costs. A favorable price variance does not mean Webb benefited from the purchase manager’s actions—this can only be determined after evaluating the effect of the manager’s actions on other parts of the business or in future periods.